1031 purchase replacement property below market value

10 Replies

Can this work for a 1031 exchange and how would this be taxed. This is an example below but easily could be done in the future of my business.

I️ sell my free and clear property for 100K, which is what it appraised for.

I️ purchase a property worth 160K for 90K and it needs 10K repairs and I️ wanted to use that 10K left over to invest in the property I’m purchasing.

What happens in this scenario if I️ wanted to do a 1031 exchange. Technically I’m buying a like kind property worth more than the property I’m selling just my purchase price is lower than what the property is worth.

What it’s worth is irrelevant.....it’s what you pay for it that counts(and yes you can include repair/improvement costs If done properly, and within the 180 day window)

@Mike Flora , Your purchase price is what determines the replacement value.  If you sell for $160K and buy for $90K there is a potential taxable boot of $70K.  

Unless your gain justifies a reverse improvement exchange there are only a few tricks that can help you in that situation.

Your model would work well if you purchased 2 or 3 replacement properties and had some outside cash to do the improvements.  Then you could refinance and reimburse the improvement costs.

Purchase price not including the renovation. Also sold price not appraised value. You can include the latest improvement to come up with a slight cost basis. Check with your CPA.

Thanks guys, I️ appreciate it. @Dave Foster I️ was stating if I️ sold my property for 100K and 1031 into a property worth 160K but my purchase price on the property worth 160K was only 90K and I️ wanted to use the 10K left over on the property for repairs what would happen. As it sounds from all you guys I️ can use the 10K left over to use for repairs on my new property I️ exchanged into.

Originally posted by @Mike Flora :

 As it sounds from all you guys I️ can use the 10K left over to use for repairs on my new property I️ exchanged into.

I don't believe you can, but your qualified intermediary can.  Your QI will have to do the renovations for you out of your exchange proceeds, then transfer title to you when the rehab is complete.  

@Dave Foster or @Bill Exeter can give more specific details.

@Mike Flora , sorry this got lost in the shuffle till @Dave Toelkes kind shout out.

First issue - You have to  purchase at least as much as you sell if you want to avoid all tax. It's not just the cash.   So if you sold for $160k then you have to buy $160K in real estate.

Second issue - Part of your purchase can be improvements but only if they can be done so that you take title to the improved property.  Again, to your example, if you sold for $160K and the property you wanted to buy was $90 K but needed $70K in improvements it must be done so that when you take title it is worth $160K.

This would be an improvement exchange.  Your QI must take title to the new property with an entity called the exchange accommodating title holder (using your funds in the exchange acct. is fine).  Then improvements must be made while the QI entity owns it (again  proceeds from your exchange acct. can be used).  After that is complete then the property is worth $160K and you can take title to it.  You would have sold for $160 and purchased for $160.  Complete exchange all is well.

The problem with all forms of reverse exchanges is that the relatively complex structure causes them to be relatively expensive compared to a regular exchange.

Hi @Mike Flora

I think your original post indicated that you would be selling your relinquished property for $100,000 and not $160,000.  In this case, if you sell for $100K and then buy for $160K you have met your "top line" number by acquiring a property of equal or greater value.  However, if you only reinvest $90K of the cash and have $10K left over, the $10K would be taxable boot because it was not reinvested.  

You can do an Improvement 1031 Exchange where we as the Qualified Intermediary would acquire and hold legal title to the replacement property and then use the balance of the $10K to make the improvements.  However, the fees associated with an Improvement 1031 Exchange (also referred to as a Build-To-Suit 1031 Exchange or Construction 1031 Exchange) would not justify doing so for only $10K. 

Does that help? 

@Bill Exeter yes thank you, I was just wondering cause I would be buying a property worth more than 100K, which I sold my property for, but buying at a lower price than 100K. I know the rules are buying equal or greater for your replacement property and my replacement is worth 160K, more than my sale property of 100K, I’m just buying it for 90K. So the 10K extra would be taxed or would the whole 100K be taxed and kill my exchange???

Hi @Mike Flora

You would only be taxed on the difference of $10K if you sold for $100K and reinvested at $90K.  However, the closing costs might "eat up" the difference.